Markets cheered the announcement last week that central banks across the globe were banding together to flood European banks with dollars. Investors were thrilled to see a coordinated global effort to stem the crisis, and the liquidity gives banks some much-needed breathing room.
However, the reality is this programme is hardly the answer to Europe's woes. At best, it puts some confidence back in the system and buys a little bit more time, but the continent remains on the precipice. The question that investors really need to be focused on is if the euro is going to survive. It is still possible to save the common currency, but it is looking more and more likely that it won't be.
Euro Stress
The next few months are going to create incredible stress on the euro. There are a few events on the horizon that could lead to a breakup of the currency.
The most obvious scenario involves Greece. It shouldn't come as a surprise to anyone that we are on the verge of a Greek default. Instead of accepting whatever terms the European Union puts on offer, the Greek government could decide that they are better off going it alone, and it isn't hard to see where they are coming from. Not many people would want to accept years, if not decades, of austerity and slow growth when you have a chance to devalue your currency and make your exports that much more attractive.
But it isn't going to be a pretty sight. Greek depositors would see their life savings redenominated from euros to drachmas, and drachmas are going to be worth a heck of a lot less than euros. So in order to keep all of the country's money from fleeing overnight, the move would have to be unannounced and the country would need to institute extensive capital and maybe even travel restrictions to keep all deposits from fleeing the country.
Furthermore, as the world watches this happen, the silent bank runs in Spain, Italy, and elsewhere in Europe will cease to be silent. Citizens of other troubled countries will rush to move their cash to safe havens so they wouldn't have to face the painful devaluation that the Greeks just experienced. The resulting bank failures and chaos would likely spell the end of the eurozone as we know it in short order.
Another option is that Germany, along with the Netherlands perhaps, gets fed up with being tied to the weaker European countries, and it pulls out of the eurozone unilaterally. Given how unpopular talk of bailing out Southern Europe is in these countries, there might be some pressure from citizens to pull out of the economic zone and go it alone. This would leave a eurozone rump that might or might not hold together. Either way, the euro as we know it today would fail to exist.
Beyond these two most obvious paths, there are surely other ways that we haven't even imagined yet that could bring the common currency down. Long story short, the system is going to be incredibly stressed, and that stress could easily bring down the euro.
Can the Euro Be Saved?
This disaster scenario isn't set in stone yet. There are concrete steps the EU could take to save the currency if the member nations have that intention. Immediately, the European Central Bank needs to step in with unlimited guarantees for all euro-denominated sovereign debt. The central bank must make a clear stand that it's behind the debt, and it can then reduce some of the short-term uncertainty surrounding the ability of eurozone counties to roll over debt.
The next step would be for the EU to create a tighter fiscal union. This could take any number of different forms, but key factors are that members should be jointly responsible for each other's debt and that there would be real consequences for running big budget deficits.
But Will It?
Just because the euro can be saved doesn't mean it will be! There are so many political obstacles to a workable plan being implemented and so many stakeholders with veto power that it seems more likely than not that the euro won't be saved. Here are a handful of problems:
Average Germans Don't Want This
Although Germany has gained a lot from the European project, there is not a huge desire among ordinary Germans to bail out countries that they see as having spent recklessly during the boom. This makes it very politically tricky to reach any solution that permanently bonds Europe together in a fiscal union. Chancellor Angela Merkel is in many ways boxed in by domestic political concerns to make any truly bold moves.
ECB Is Reluctant
The European Central Bank is also not jumping up for joy at the prospect of a huge expansion of its bond-buying programme. The ECB has fought hard to not break out of its statuary role of providing price stability across the eurozone, and it has said time and time again that its bond buying will remain limited. No plan can work without lots of involvement from the central bank, so getting it on board is crucial.
Changing Rules Is a Nightmare
A fiscal union will need to be approved by every member of the eurozone. Remember how reluctant Slovakia was to approve the expansion of the European Financial Stability Facility? How excited is that nation going to be about a permanent fiscal union? Getting everyone to agree on one plan, where a single vote can bring down the entire round of negotiations, is a recipe for getting nothing done.
It's a Lot to Do in a Short Time
This plan isn't going to happen quickly. The negotiations could take months, and true implementation could very well happen over years. But the crisis is critical and needs an immediate solution. A lot of decisions will have to made quickly, and the markets have to believe that changes are actually going to be implemented and not fall apart. A tall task.
The truth of the matter is no one knows if the euro is going to fail. But every day that goes by without reforms to the system, the likelihood rises. If Europe is serious about saving the euro, the countries need to have a real plan in place by the Dec. 9 meeting. If that summit produces another unworkable solution, it might be too late to save the common currency.
What are your thoughts on the situation? Do you see the eurozone attaining financial stability, or is this its swan song?
Bearish markets editor Bearemy Glaser is the worry-prone alter-ego of markets editor Jeremy Glaser. Each week Bearemy shares what's topping his list of concerns and invites you to reply or add your own in the comments section below.
